Variance Analysis and Internal Controls

This article discusses variance analysis and internal controls in the context of Colorado Springs Pty Ltd. It includes recommendations for cost control and cost reduction, areas of concern for managers, and internal controls to prevent errors and frauds.

Running Head: Variance Analysis and Internal Controls
MANAGEMENT ACCOUNTING

Variance Analysis and Internal Controls 1
Part One:
Question 1:
Appendix 1
Question 2
Variance occurs due to difference in the budgeted results and the results that are actually
received. Generally, variances are categorised into two categories i.e. favourable variances
and unfavourable variances. Favourable variances are those differences which has positive
impact on the overall performance of the firm. Unfavourable variances, on the other hand, are
those differences which imposes negative impact on the company’s performance in total
(Drury, 2013).
In the present case of Colorado Springs Pty Ltd, the variance analysis of the performance of
company’s NSW region has been made in financial terms for the last three months i.e. June,
July and August. Over the period of these three months, the variances with the largest
percentage are identified and analysed to find the reasons of such variation, between actual
performance and budgeted performance.
 The highest variance is reported in the month of August in relation to interstate travel
expenses incurred for the business. For all the three months it was expected that $
2000 will be incurred to undertake the travelling from one state to another for the
business purposes. However, in August $6450 has been actually incurred in this
respect possibly because of the reason that the number of visits to different states for
the purpose of conducting business tours must have increased. The said increase of
222.50% in the interstate travelling expenses could be because of an increase in the
fare charges of travelling.

Variance Analysis and Internal Controls 2
 The second largest variance in percentage terms is with respect to the profits earned
by the company in August. The budgeted profit was $ 76945 but due to over spending
on the business expenses and generation of lesser sales than the anticipations has
caused the company to incur loss in place of profit. This has resulted in the variance
of 167.82% (negative). The increase in expenses such as sales commission, office
rent, delivery costs, office wages expenses and the payment for phone and internet
bill, have majorly contributed to the variations. Further, the company did not have
expectations of overtime work requirements but in actuality it had to make overtime
payment to warehouse staff as well as office staff (Garrison, et. al., 2010).
 The third largest variation in percentage terms was reported in respect of stationary
expenses in the month of June. The actual stationary expense is 156.80% of the
budgeted expense in this regard. This might be due to over spending on buying
various stationary items for the business.
 The fourth largest percentage of the variation in the actual performance and budgeted
performance is in the areas of electricity consumption expenditure. In July, the actual
electricity expense was around 135% of its budgeted electricity expense. The reasons
of such significant variation could be various such as over usage of electricity in the
administrative functions of the business such as keeping the electric devices turned on
for all the time or due to the more business administration function.
 The fifth largest variation in percentage terms has also occurred in the month of July
in respect of printing expenses undertaken in the business. The actual printing
expenses in July are approximately 125% of the budgeted printing expense. The
reason of such significant variation could be the increased printing facilities availed
by the company or due to the increase in the rate of printing functions.
Recommendations:

Variance Analysis and Internal Controls 3
From the above analysis, it could be observed all the variances which are significant enough
in percentage terms are negative or unfavourable. The unfavourable variances occur due to
poor budgeting or forecasting functions where the company could not estimate the
appropriate amount of expenditure (Hilton & Platt, 2013). Therefore, it is recommended to
the company to use appropriate and more realistic bases such as trends or assumptions, to
estimate such amounts. Further, it is also recommended to continuously monitor the budgets
that have already been prepared to closely check if there is any need of alteration to be made
in the budgeted amounts due to occurrence of any unexpected or unusual event such as
changes in the market condition or due to any new business requirement (Uyar, 2010). In all
the three months, the actual net profit is lower than the forecasted profits. So, it is highly
recommended to the company to lower down its excessive spending on certain expenditures
which could be controlled using the cost control and cost reduction approaches. Further, it
would be suggested to the company to prepare the budget of next quarter by keeping in mind
the actual results of the current quarter budget and not only on the basis of earlier forecasts or
estimations which have proved to be redundant.
Question 3:
The areas where the above discussed variances has occurred are definitely the ones which
have the potential to raise concern in the eyes of the managers because of the higher degree
of variations in the actual and budgeted results. However, it cannot be said that only those
areas that have been identified and reported above demands manager’s attention. Rather,
there are various other areas which are required to be essentially considered while analysing
the variances in the budgeted statement (Horngren, et. al., 2010). These areas are revenue
growth, profitability position both in terms of gross profit and net profits, the cost of sales as
well the overall expenses of the business. The actual sales revenue in July and August was
did not meet the budgeted standards. However, the cost of goods sold was higher than the

Variance Analysis and Internal Controls 4
amount that was estimated in this respect in June and August due to which Chapman Ltd
could not meet the anticipated profitability. Further, the payment of overtime wages to the
office staff and warehouse staff was also the matter that was required significant attention of
the managers while analysing the variances as this type of expenses were not at all estimated
to be incurred in the normal course of business. So, the occurrence of such expenses in all the
three months under consideration calls for the managers to identify the reasons of such
overtime payment and what was the benefit derived by the company from making its
employees work for the overtime.
Question 4:
The areas over which a manager can have influence are those areas under which cost or
expenses could be controlled. These areas are discussed below:
 Phone and internet: Chapman Ltd could reduce the amount spent on phone bills by
using cost effective mailing systems which involved incurrence of nominal charges.
Also, it can make use of various cost effective internet plans to reduce the cost of its
internet usage. Further, the managers of the company must induce such policies where
the use of company’s internet and phone facilities must be restricted to only official
use and the employees must not be allowed to use company’s resources for their
personal use.
 Electricity: The electricity expenses could be reduced to a certain extend if the
excessive consumption of power is cut down. The managers of company must bring
in the power usage policies. These policies must define and explain as to how
electricity could be consumed appropriately without wastage. The managers must
instruct the staff members to turn off the office devices and plants during the period of
inactivity.

Variance Analysis and Internal Controls 5
 Printing and stationary: The printing and stationary expenses are generally of nominal
amount. However, the expenses incurred in such areas can be reduced by making
effective utilisation of printing machines and stationary items of the office. The paper
work must be reduced by the company and in place of this the company must start
maintaining its important documentation on the electronic mode so as to avoid
incurrence of excessive printing and stationary expenses.
 Sales: The managers of Chapman Ltd could increase the quantum of its sales by
introducing attractive discounts and schemes so that more and more customers in the
market could be targeted. Use of effective sales and marketing strategies could also
help the company to increase its revenue from the sales (Zimmerman & Yahya-
Zadeh, 2011).
 Interstate Travelling cost: The managers of Chapman Ltd can reduce its travelling
costs by various ways such as reduction in the visits made to different states or by
using cost effective modes of transportation and accommodation facilities
Question 5:
The areas in the budgetary statement where the managers have very little control in the short
run are as follows:
 Depreciation expenses: The depreciation expense on property, plant and equipment
could not be reduced significantly as depreciation is a mandatory charge. The
managers can at maximum change the way method of depreciation but in short run it
would also not serve as an effective cost control method (Hansen, Mowen &
Madison, 2010).
 Repair and maintenance: The machines and equipment by their very nature requires to
be maintained appropriately and often demands some repairing work over a period of

Variance Analysis and Internal Controls 6
time. So the cost incurred in repairing and maintaining such PPE is unavoidable in
nature.
 Office rent: The rent of the building could only be avoided if the managers purchase
their own property through which they can conduct the business of the company. But
in short run it is not possible to make such a heavy investment in purchasing an office
property.
 Delivery cost: The cost of delivering the products could not be influenced much by
the company in short run as delivery is an essential part of business sales operations
without which customers cannot be retained in the business. If alterations are made to
the mode or quality of the delivery services, it might cause damage of the products
delivered to the customers.
 Office and warehouse wages: The payment of wages cannot be controlled much in the
short run. In long run company can propose to make an investment in automated
business operations where labour cost on manual operations could be reduced. But in
short term it is not a feasible option (Drury, 2013).
Part Two
Part i
Internal controls are the controls which are required to put in place to achieve the operational
efficiency of the company. Only existence and functioning of proper internal controls at
various significant areas can enable a company to undertake the financial reporting function
accurately without any errors or mistakes (Doyle, Ge & McVay, 2007). Also, the strong
internal controls help the external auditors of the company to effectively carry out the audit
engagement of the company.

Variance Analysis and Internal Controls 7
 Lack of physical verification: Before delivering the final goods to the customers there
was no process undertaken by any authorised person to take the physical count of the
items ready to be dispatched so as to ensure the appropriateness of the quality and
quantity.
 Untrained employees: The new sales person where placed by the company in place of
old sales person who have been working with the company for a considerable amount
time. Hence, it becomes difficult for the novices to understand as to how to deal
adequately with the new customers. Also, the new sales person could not differentiate
between the new and existing customers of the company and hence provided the price
sensitive information to the persons who were not even the customers of the company.
 Segregation of duties: The sales order were not even authorised by the proper body
before dispatching the goods. Further, the credit notes issued to the customers for the
short deliveries made to them were not authorised by a person who is not associated
with the person who is entrusted with the duty of creation of sales ledger functions.
The sales invoices were not also checked by the person who created such invoices for
the price check or any casting or other type of errors contained in the invoices.
 Lack of proper documentation: Chapman Ltd did not produce any dispatch notes
using the sales order issued by the duly authorised sales person.
 Non authorisation of the sales transactions: The sales were made to certain builders
without issuing proper invoices which had caused undertaking of non-authorised sales
transactions by the fraudulent sales managers. Due to lack of authorised sales
transactions, the sales person and delivery persons had jointly manipulated the sales
data and taken the undue advantage of their positions.
Part ii

Variance Analysis and Internal Controls 8
All these weakness in the internal controls had led to occurrence of errors and frauds on part
of management of company. Hence, there must be strong internal controls put in place in the
areas of sales and trade receivables management so as to avoid any discrepancies in the
normal business operations (Lin, et. al., 2011). Following are the internal controls that are to
be undertaken by Chapman Ltd to strengthen its internal controls with the aim of avoiding
any sort of errors and frauds on part of any internal party of the company:
 There must be proper verification of the all the physical goods before dispatching
them to the final customers so as to ensure that all the sales order requisites are
fulfilled. The physical stocking will enable the company to timely deliver the required
quantity as well as quantity of the goods to its customers. This type of internal control
will prevent the risk of errors in the order deliveries.
 All the new sales personnel must be given adequate amount of training and
orientation with the existing customers on records so as to acknowledge them about
the background and significance of such customer to the company. Imparting of
adequate training to them will also allow them to learn about the ways of dealing with
the exiting as well as new customers. This type of control will help the company to
avoid the risk of transfer of sensitive product price related information to the third
parties.
 The sales transaction must be authorised by an official representative. Mere
involvement of sales personnel as well as delivery person enables them to take undue
advantages of their position within the company. Hence all the sales transactions must
be duly authorised before dispatching and even after dispatching the goods. This type
of internal control will allow the company to avoid the risk of manipulation of sales
records and inventory record by the interest parties.

Variance Analysis and Internal Controls 9
 Further, there must be a system of having all the sales order appropriately pre-
numbered so that an adequate check can be made that ensures that all the orders have
been evaluated for the completeness check.
 There must be proper segregation of duties for all the functions from receiving the
sales order from the customer to the dispatching of goods and receiving customers’
confirmation as well as recording the sales transaction into the accounting books.
When all said functions are appropriately segregated and assigned to the different
officials, there will be higher chances of independent check on all such transaction
events which could avoid occurrence of any manipulation or any other type of fraud.
 Only authorised sales transactions entered into by the company and its customers
must be entered into the accounting books so as to prepare such financial statements
which depict true state of company’s financial affairs.
 Invoices as well as credit notes must be adequately checked for the accuracy and all
such documents must be duly authorised before making entry related to such
transactions in the books of accounts.
 There must be a record of all the existing customers with the new sales personnel so
that they can easily identify the new customers with the company before entering into
sales deal with such parties. This control will prevent the risk of mishandling of the
customers of the company.
 Further, the dispatch notes must be pre-numbered and such documents must be
matched with the customer orders as well as the customer invoices before recording
the same in the books of accounts (Louwers, et. al., 2015).

Variance Analysis and Internal Controls 10
References:
DRURY, C.M., 2013. Management and cost accounting. Springer.
Hilton, R.W. and Platt, D.E., 2013. Managerial accounting: creating value in a dynamic
business environment. McGraw-Hill Education.
Zimmerman, J.L. and Yahya-Zadeh, M., 2011. Accounting for decision making and
control. Issues in Accounting Education, 26(1), pp.258-259.
Garrison, R.H., Noreen, E.W., Brewer, P.C. and McGowan, A., 2010. Managerial
accounting. Issues in Accounting Education, 25(4), pp.792-793.
Uyar, A., 2010. Cost and management accounting practices: a survey of manufacturing
companies. Eurasian Journal of Business and Economics, 3(6), pp.113-125.
Horngren, C.T., Foster, G., Datar, S.M., Rajan, M., Ittner, C. and Baldwin, A.A., 2010. Cost
accounting: A managerial emphasis. Issues in Accounting Education, 25(4), pp.789-790.
Hansen, D.R., Mowen, M.M. and Madison, T., 2010. Cornerstones of cost accounting. Issues
in Accounting Education, 25(4), pp.790-791.
Lin, S., Pizzini, M., Vargus, M. and Bardhan, I.R., 2011. The role of the internal audit
function in the disclosure of material weaknesses. The Accounting Review, 86(1), pp.287-323.
Louwers, T.J., Ramsay, R.J., Sinason, D.H., Strawser, J.R. and Thibodeau, J.C.,
2015. Auditing & assurance services. McGraw-Hill Education.
Doyle, J.T., Ge, W. and McVay, S., 2007. Accruals quality and internal control over financial
reporting. The Accounting Review, 82(5), pp.1141-1170.

Variance Analysis and Internal Controls 11
Appendix 1:
Expenses
Budg
eted
Amo
unt
Actu
al
Amo
unt
Var
ianc
e in
$
Vari
anc
e in
%
Budg
eted
Amo
unt
Actu
al
Amo
unt
Var
ianc
e in
$
Vari
anc
e in
%
Budg
eted
Amo
unt
Actu
al
Amo
unt
Var
ianc
e in
$
Vari
anc
e in
%
Sales
Salaries
1950
0
1950
0 0
0.00
%
2437
5
2430
0 -75
-
0.31
%
1950
0
1950
0 0
0.00
%
Sales
Commissi
on
2460
0
2528
1.6
681.
6
2.77
%
3225
0
2875
2.75
-
349
7.25
-
10.8
4%
2250
0
2383
9.2
133
9.2
5.95
%
Warehous
e Wages
2200
0
2240
0 400
1.82
%
2750
0
2762
0 120
0.44
%
2200
0
2212
0 120
0.55
%
Warehous
e Wages
Overtime 0 2350
235
0 0 1980
198
0 0 2300
230
0
100.
00%
Offices
Wages
1800
0
1680
0
-
120
0
-
6.67
%
2250
0
2262
0 120
0.53
%
1800
0
1910
0
110
0
6.11
%
Office
Wages
Overtime 0 2150
215
0 0 3100
310
0 0 3800
380
0
100.
00%
Managem
ent
Salaries
1900
0
1900
0 0
0.00
%
1900
0
1900
0 0
0.00
%
1900
0
1900
0 0
0.00
%
Superann
uation 9795
1021
1 416
4.25
%
1193
4
1210
0 166
1.39
% 9880
1041
8 538
5.45
%
Advertisin
g
1600
0
1496
0
-
104
0
-
6.50
%
1800
0
2396
0
596
0
33.1
1%
1600
0 8250
-
775
0
-
48.4
4%
Sales
Vehicles
Fuel 600 710 110
18.3
3% 800 912 112
14.0
0% 600 1020 420
70.0
0%
Maintena
nce 500 300
-
200
-
40.0
0% 500 65
-
435
-
87.0
0% 500 1078 578
115.
60%
Depreciati
on 1500 1500 0
0.00
% 1500 1500 0
0.00
% 1500 1500 0
0.00
%
Delivery
Costs
1640
0
1685
4.4
454.
4
2.77
%
2150
0
1916
8.5
-
233
1.5
-
10.8
4%
1700
0
1942
0
242
0
14.2
4%
Warehous
e Rent
4000
0
4000
0 0
0.00
%
4000
0
4500
0
500
0
12.5
0%
4000
0
3500
0
-
500
0
-
12.5
0%
Office 2400 2400 0 0.00 2400 2400 0 0.00 2400 3400 100 41.6

Variance Analysis and Internal Controls 12
Rent 0 0 % 0 0 % 0 0 00 7%
Electricity 1600 2100 500
31.2
5% 1600 3758
215
8
134.
88% 1600 1410
-
190
-
11.8
8%
Phone &
Internet 1000 980 -20
-
2.00
% 1000 1974 974
97.4
0% 1000 2098
109
8
109.
80%
Equipmen
t Repair &
Maintena
nce 800 230
-
570
-
71.2
5% 800 85
-
715
-
89.3
8% 800 1470 670
83.7
5%
Local
Travel 600 50
-
550
-
91.6
7% 600 260
-
340
-
56.6
7% 600 310
-
290
-
48.3
3%
Interstate
Travel 2000 0
-
200
0
-
100.
00% 2000 3120
112
0
56.0
0% 2000 6450
445
0
222.
50%
Staff
Amenities 400 380 -20
-
5.00
% 400 620 220
55.0
0% 400 310 -90
-
22.5
0%
Stationary 250 642 392
156.
80% 250 157 -93
-
37.2
0% 250 87
-
163
-
65.2
0%
Printing 375 210
-
165
-
44.0
0% 375 845 470
125.
33% 375 165
-
210
-
56.0
0%
Depreciati
on
Office
Equipmen
t 1800 2150 350
19.4
4% 1800 2150 350
19.4
4% 1800 2150 350
19.4
4%
Warehous
e
Equipmen
t 1250 1250 0
0.00
% 1250 1250 0
0.00
% 1250 1250 0
0.00
%
Total
Expenses
2219
70
2240
09
203
9
0.92
%
2539
34
2682
97.3
143
63.2
5
5.66
%
2205
55
2360
45.2
154
90.2
7.02
%
Net Profit
5303
0
3723
6
-
157
94
-
29.7
8%
1210
66
5756
7.75
-
634
98.3
-
52.4
5%
7694
5
-
5218
5.2
-
129
130
-
167.
82%